- Shareholder IRS audits may occur if there are discrepancies in shareholder tax returns or the agency believes income or deductions weren’t reported properly
- Related-party transactions can also trigger these types of audits
- Related-party transactions are when closely related parties make a deal or arrangement for a business benefit
- Twelve mistakes to avoid during shareholder IRS audits:
- Trying to manipulate tax laws
- Not being prepared regarding related-party transactions
- Failing to be organized
- Overstating your deductions
- Omitting income sources
- Ignoring notices from the IRS
- Failing to submit accurate information
- Not using previous documentation
- Neglecting changes in tax laws
- Claiming ineligible business expenses
- Making careless errors
- Not having knowledgeable representation
- Working with a tax attorney is the best way forward when you’re facing a shareholder IRS audit
Running an S corporation business brings a lot of benefits, like pass-through taxation and avoiding the double taxation many C corporations have to deal with. An important thing to remember for S corporations, however, is that shareholders of the business are considered employees for tax purposes. Failing to account for this fact can lead to confusion and even IRS audits. The agency pays close attention to S corporations and their shareholder information because many taxpayers manipulate tax laws to get greater business benefits.
What triggers a shareholder audit? What should you do if you’re facing an IRS audit? This guide walks through what these audits look like, key considerations for shareholders, and common mistakes to avoid during these types of audits.
What Is a Shareholder IRS Audit?
A shareholder IRS audit is a thorough review of the tax returns and financial records of a business or individual shareholder to ensure they are compliant with local, state, and federal tax laws. The IRS can initiate an audit on its own or if it receives information from another source that suggests there may be discrepancies in the reported filing.
The IRS will conduct an extensive review of the books and tax documents of the business or individual shareholders to determine whether they are declaring all income, taking appropriate deductions, and paying taxes correctly. The result of this audit could be a refund from overpaid taxes if everything is in order, or alternatively, a taxpayer could face charges for unpaid taxes if the IRS finds discrepancies.
An IRS audit of a shareholder’s return is a comprehensive review of the accuracy and adequacy of the return. The audit process involves gathering documents, examining records, verifying information, and reconciling accounts. Shareholders may need to provide additional details or documents that prove their income was reported accurately. They may also be required to respond to questions about deductions or other items reported on the tax return.
Audits can be time-consuming and stressful, so it is important for taxpayers to be prepared and be able to explain all of the information on their return. Working with a tax professional is a good idea when you’re dealing with any type of audit.
The sRelated-Party Transactions IRS Agents Review
One component involved in many shareholder audits is the review of related-party transactions. Related-party transactions are financial agreements, such as loans, payments, or stock acquisitions, between two parties who have a pre-existing relationship. These parties can be individuals, corporations, limited liability companies, trusts, and other business organizations.
An example of a related-party transaction is when shareholders of a company loan money to the company itself. Related-party transactions often play an important role in businesses as they provide access to capital that may not be available from traditional sources. The IRS and other agencies carefully monitor these types of transactions, however, because of their close nature and potential for abuse. This helps ensure the interests of all involved parties are met fairly and that no laws are violated. The IRS may audit a business’s related-party transactions if it has reason to believe any of the following are true:
- The terms of the transaction are not fair or reasonable
- The transaction is outside the normal course of business
- There is any indication of fraud
It’s also worth noting that an audit can be triggered if a company’s financial statements are not properly documented and show an excessive amount of transactions with related parties. An audit may also happen if the value of property transferred between related parties does not match the reported value on tax returns. Companies engaging in related-party transactions need to make sure all documentation is accurate and activities comply with tax laws to avoid potential audits from the IRS.
Twelve Mistakes to Avoid During a Shareholder Audit
Tax season is stressful for many businesses, and it can be especially challenging when the IRS comes knocking on your door. A shareholder IRS audit is an intensive process that requires a lot of preparation, so making a mistake could lead to costly consequences. Here are 12 mistakes to avoid during a shareholder IRS audit:
1. Trying to Manipulate Tax Laws for S Corporations
Don’t try to manipulate laws to skip paying taxes. Avoiding this mistake can help you prevent an audit in the first place or make the process go faster. Some S corporation owners, for example, don’t report a salary for themselves to avoid payroll taxes. The law states that S corporation shareholders who are employees must receive reasonable employee compensation for the services they provide, and that compensation must be separate from their distributions. Audits may be triggered if the S corporation owner doesn’t receive a salary, or it’s a very small one.
2. Not Being Prepared for Related-Party Transaction Questions
The IRS may review compensation, transfer pricing, shareholder loans, or buy/sell agreements in regard to related-party transactions. These commonly trigger audits. Closely held corporations or family-owned corporations will likely see these kinds of issues. Sometimes shareholder tax returns will be requested and audited if corporate-level adjustments impact these tax returns. Be prepared to provide, review, and defend the information you provide in these matters.
3. Failing to Be Organized and Prepared With Relevant Documents
Make sure to have all necessary documents and records organized in advance. This may require careful attention to detail and better storage practices all year long. Being organized helps ensure you can provide information to auditors quickly and may speed up the audit process.
4. Overstating Your Deductions
Overstating deductions on an S corporation or shareholder’s tax return can be a costly mistake, but many owners may do it to try to lower their tax obligations. Do not try claiming more deductions than what is legally possible. Doing so could result in not only a lengthy audit, but also serious penalties and even charges from the IRS. This is a big issue many business owners run into, and it is often what causes IRS audits.
5. Omitting Income Sources
Don’t forget to report all income sources, even if they feel like small amounts of money to you or the business. The IRS needs to know about every form of income. You could face underreporting penalties or even criminal charges if you omit revenue streams. S corporation owners need to accurately report everything on their tax returns.
6. Ignoring Notices From the IRS
Never ignore any letter or notice if the IRS contacts you about completing additional forms or requests for information. Take immediate action and comply as soon as possible. You could be subject to additional penalties or charges otherwise. You need to carefully comply with an IRS audit to stay in good standing with the agency. The initial IRS notices you receive will have deadlines for a response on them, so make sure you respond promptly.
7. Failing to Submit Accurate Information
Ensure all information submitted is correct, up to date, and accurate. The IRS has already seen some kind of red flag with your tax return, so don’t make it worse by supplying them with false information. Provide everything they ask for, including proof of your numbers if requested. This is an important moment when you have to be honest and transparent about business transactions.
8. Not Using Previous Documentation
Some shareholders may have gone through the audit process in the past. You can significantly speed up the audit process and increase accuracy by using the same documentation and information you submitted previously. Look at your past information if you’ve been through an audit before or the IRS requested document corrections in the past. This can also help you be consistent.
9. Neglecting Changes in Tax Laws
Make sure all deductions taken and credits claimed are allowed by current legislation. Tax laws change significantly over time, so make sure you and the business have processes in place for reviewing changes to legislation and new tax relief initiatives you may be eligible for. Always ask a legal professional if you’re not sure how a tax law impacts you or your business.
10. Claiming Expenses Not Directly Related to Business Activities
All deductions on your tax return related to expenses need to be directly related to business activities. You can’t claim personal expenses with no link to the business. These can raise flags for the IRS during audits. Review everything to make sure your reported expenses are actually eligible to be deducted.
11. Making Careless Errors
Accuracy and precision are key to avoiding costly errors during an IRS audit. Double-check your figures before submitting everything to the IRS as requested. It is important to have organized paperwork such as receipts, invoices, and other documents that can back up your claims. Small errors like typos or transposed numbers can cause big discrepancies or problems. Review all your records to make sure everything aligns with what you’re reporting for the business.
12. Not Having Knowledgeable Representation
Audits are never easy to face, especially when you’re on your own. It is important to have an experienced accountant or tax professional to help you navigate the process if you are audited. Professionals understand why your tax return was flagged, what the IRS is requesting, and your best approach for a response.
Being aware of potential mistakes associated with a shareholder IRS audit will help you prepare mentally for what may be ahead and prevent costly mistakes during the process. Remember to reach out to a tax attorney when you’re dealing with a shareholder audit or related tax issue.
Contact a Tax Attorney at Silver Tax Group for Assistance
Facing an IRS audit can be a big deal for businesses and shareholders. Audits mean the agency has found something in your tax return they need to look into further, and the best thing you can do is comply with the audit and be open and honest about everything.
Shareholder IRS audits are thorough processes that can lead to costly mistakes if you don’t properly prepare. It is essential to make sure you have all of the necessary documents, records, and information organized ahead of time in order to streamline the process. It is also beneficial to have knowledgeable representation in your corner, such as an experienced accountant or tax professional. Avoid common mistakes along the way to save yourself from unnecessary stress or expenses during a shareholder audit.
The team at Silver Tax Group is ready to help you through shareholder IRS audits. These audits require a specific set of considerations and tax laws, and they’re not to be taken lightly. Our team of tax attorneys will help ensure you’re doing everything the right way so you don’t face any additional penalties or criminal charges and so the audit moves along quickly. Reach out to Silver Tax Group to speak to a tax expert about shareholder IRS audits and related-party transactions.